Congress likely to shrink mortgage deduction

Once considered untouchable, the tax break available to homeowners for the interest they pay on their mortgages is now vulnerable to new limitations that are likely to have an bigger impact in Connecticut than in most of the rest of the nation.

One of the oldest tax breaks, the mortgage interest deduction is designed to encourage home ownership.

But it costs the federal government more than $80 billion in lost revenue each year. As Congress looks to avoid looming deep automatic spending cuts, the pressure to shrink the mortgage interest "loophole" is growing.

"We feel there will be some kind of change, but we don't know yet what that would be," said Sean Fergus, manager of research at California-based John Burns Real Estate Consulting.

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A leading proposal would cap the amount of mortgage eligible for interest deductions at $500,000. Another would eliminate the deduction on second homes, and/or second mortgages.

President Obama and others have urged a capping of all deductions, at $25,000, $35,000 or some other amount, which could affect the amount of mortgage interest that could be claimed by many taxpayers.

Connecticut's realtors are opposed to all of those proposals.

"We've had this deduction for 100 years and no administration has had to do away with it to balance the budget," said Bob Kimball, a realtor in Mystic who is president of the Connecticut Association of Realtors.

Any limitation of the mortgage interest deduction would affect Connecticut homeowners more than most others because the state has high-priced homes compared with the national average. The national median home price is about $182,000. The median home price in Connecticut is $282,000, and many homes in Fairfield County and other areas of the state cost much more than $500,000.

In addition, there are many second homes in Connecticut. If the mortgage on those homes are added to the mortgage on a primary residence, it's likely the total could exceed $500,000.

A report released last year by John Burns Real Estate Consulting said only five metropolitan areas -- all of them in California -- would be impacted more than the Bridgeport-Stamford-Norwalk area by limiting interest deductions to mortgages that are $500,000 or less.

The report said the taxpayers in that area of Fairfield County would lose more than 11.1 percent, or about $82 million, each year in if the cap went into effect.

"It's almost a penalty for living in a high cost-of-living location," Fergus said.

Kimball said every homeowner would be hurt by any reduction of the mortgage interest deduction because it would lower all real estate prices and hurt the recovery of the real estate industry. He also said that any change in the mortgage interest deduction would "open the door" to more limitations, and eventually the elimination of that tax break.

"One sort of bright spot (in the economy) is that housing is beginning to recover," he said.

But Rep. John Larson, D-1st District, said some change to the deduction "is likely to be part of a greater deal" to avoid a "fiscal cliff" at the end of the year. That's when a series of tax breaks expire, and deep spending cuts are imposed unless Congress comes up with $109 billion in savings and new revenues.

So the hunt on Capitol Hill to close loopholes has begun. Some lawmakers, like Larson and Sen. Richard Blumenthal, D-Conn., say they are trying to limit the impact of shrinking and eliminating tax deductions on middle-class Americans.

"I've generally been against eliminating or significantly modifying the home interest mortgage deduction," Blumenthal said. "But there may be an effort, which I would support, to put a cap on all deductions."

But once again, Connecticut residents are at the top of the list when it comes to federal income tax deductions.

According to a Wall Street Journal analysis of federal tax records, California taxpayers take -- on average -- the highest itemized deductions, about $34,000. After California, the highest average itemized deductions -- all over $28,000 -- are claimed by taxpayers in New York, Washington, D.C., New Jersey, Maryland, Massachusetts and Connecticut.